As we head into this most patriotic of long weekends, commodity traders will be focusing their attention across the Atlantic where the European Central Bank (ECB) will be meeting to discuss the Euro Zone’s interest rate policy. Unlike the Fed, the ECB has been much more decisive in its policies – to a fault many will argue. The market is betting that the bank will raise rates by a quarter basis point in an attempt to curb inflation, but this policy may only exacerbate the problem instead of helping, as it will likely lead to further appreciation of the Euro versus the US Dollar. The two main forces driving inflation globally have been increased consumption by emerging market countries and the weakening US Dollar. There has already been some dissent from EU member states since ECB President Trichet all but stated the bank will raise rates at tomorrow’s meeting. Some member states have voiced their opposition to the proposed rate hike, arguing that further strengthening of the currency would put Europe at a competitive disadvantage and could lead to an economic slowdown in Europe.
Here’s a quick breakdown on how this may impact the markets:
Interest rates – US debt instruments may suffer from lower demand from overseas investors due to weak interest rate parity and currency fears. Bonds have climbed steadily in recent sessions because of the weakness in equity prices, but bullish enthusiasm may wane a bit if the ECB policy statement is hawkish. A dovish statement or inaction by the bank could excite the bull camp.
Currencies – A rate hike most likely would be interpreted as bullish for the Euro and negative for the Dollar Index. The Aussie and Canadian Dollars may get a lift on fears that the move may result in inflation kicking-up, due to the fact that both of these nations are raw material exporters. The Yen and Swiss may suffer due to the possible lure of higher rates in the Euro Zone. Then Yen may once again suffer because of the carry trade.
Metals – Precious metals have rallied in recent sessions on the coattails of the Crude Oil market. An increase in interest rates would likely bode well for the market going into the long holiday weekend. Base metals, on the other hand, may have a more difficult time finding direction from the policy statement. On one hand, higher rates may result in lower demand, which could lead to lower prices. On the other hand, some industrial metals, such as copper, have benefited from capital outflows from equities into commodities.
Energies – Energies have benefited from the weak US Dollar more than any commodity, except for the possibly grains. Barring any major geopolitical turn of events, the policy statement may set the tone for the market.
Grains/Softs – Grains and softs will likely benefit form a strong statement from the ECB, but a dovish statement does not necessarily spell doom for the grain market, considering domestic matters. A weaker greenback could lead to strong overseas demand for US grain, while Sugar would likely benefit from higher energy prices. Cocoa is somewhat of a wildcard, depending on how the Pound reacts to the announcement.